foxex: Macy's Disappointing Sales Crush Retail Stocks

Chart Advisor | INVESTOPEDIA

Focus on the Price

By John Jagerson, CFA, CMT

Thursday, January 10, 2019

1. Macy's and Kohl's crush retail stocks

2. Is the biggest risk that the Fed won't raise rates?

3. Traders may be waiting to buy the next dip

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Major Moves

The market hit a snag today after Macy's (M) managers announced that they expect comparable sales to grow 2%, which is down from previous estimates of 2.3%. The company's profit outlook was similarly downgraded. Macy's stock fell over 18% today which essentially erased its 2018 gains. A similarly negative announcement was made by Kohls (KSS), they reported that same-store sales in November and December rose 1.2%, which is a big decline from last year's 7% growth rate.

In both cases, Macy's (M) and Kohls (KSS) were bumping up against key technical pivot levels yesterday. Kohls (KSS) hit the breakout point of October's double top, and Macy's (M) was rejected at $32 per share, which was the prior support level through most of 2018. You can see that pivot level in the following chart.

This should be a concern for investors as we head into earnings season. Although the rally of the last two weeks has been a relief, it has placed a lot of stocks (not just in the retail sector) at their prior resistance pivot levels. In my experience, price action like this just prior to earning season raises the bar and makes it less likely for positive earnings surprises to raise a stock's price.

Today's micro crash in retail stocks is a perfect example of the issues that traders are facing over the next month. Although Macy's and Kohls fell on negative news, Target (TGT) and Costco (COST) also struggled during most of the session despite both announcing positive sales growth surprises. In fact, Target (TGT) hasn't seen growth this brisk (+5.7%) since 2005. This inverse "halo effect" could be a real problem for the retail and technology sectors later this month.

Which Sectors Will Lead the Market Higher?
7 Growth Stocks for 2019

Source: finviz.com

Risk Indicators

From a risk perspective, there are several positives to offset the bearishness that we observed in retail today. For example, long-term treasuries are down again; meanwhile, high-yield bonds rose which is usually a sign of improving risk appetite. Further, despite a lot of talk recently about the slowdown in China and how that may affect the global economy and commodities prices, optimism seems to be intact based on emerging market stock index prices.

Assuming we don't see a surge in profit warnings, or further deterioration in China's economy, the biggest problem for bulls may continue to be the Fed. If you were watching the major market indexes in the middle of the day today, you probably noticed a short-term zigzag in the price between 1 PM and 2:30 PM Eastern. Although it never got very extreme, that blip in volatility was a direct reaction to comments made by Fed chair Jerome Powell.

Powell gave a nod to doves by emphasizing how "patient" the Fed can be about further interest rate increases. However, in the same comments made to the Economic Club of Washington DC, Powell promised that the Fed's balance sheet will continue to shrink and should be "substantially smaller than it is now". Comments about shrinking the Fed's balance sheet can put traders on edge because it can increase the cost of capital.

The asset side of the Fed's balance sheet consists of treasury bonds, mortgage-backed securities, and other debt instruments. The Fed would reduce the size of its balance sheet by selling those debt securities. If we hold everything else equal, but the supply of debt increases from the Fed, then the price of debt securities should go down. If the price of bonds (and similar instruments) goes down, then yields or interest rates rise because they are inverse functions.

This is where I take issue with what some analysts are saying in the financial press today. It's easy to get the impression that if the Fed does anything to increase long-term interest rates (like selling bonds off their balance sheet) that the market will drop. However, historically, rising interest rates have a very strong positive correlation with rising stock prices. As you can see in the following chart, the yield on 10-year treasury bonds has been rising with stocks over the last week and a half and fell with stocks during the decline in November and December.

In my view, the real risk from the Fed is not that they will reduce the balance sheet or raise rates, but that they will remain overly accommodative and hurt confidence. We all love low interest rates as borrowers, but higher yields tend to generate more investment and are associated with growth.

Read more:

How Bond Yields Affect the Market

Do Shutdowns Affect the Market?

Understanding the Fed's Balance Sheet

Bottom line: Waiting to Buy the Next Dip

Investor sentiment seems to still be balanced on a knife's edge. Today's mini-contagion in retail stocks is a warning that volatility may increase during the initial round of earnings reports next week. More broadly, most risk indicators and fiscal stimulus in China are pointing towards a continued recovery – at least in the short term. I would expect that if stock prices cool off over the next two weeks, investors will move back in and buy the dip again towards the end of January.